Brian Ashcroft

Many apologies to my readers for not posting anything for the last two years! The result of the BREXIT referendum and my retiral from the Fraser of Allander Institute led me to retreat from economics and the Scottish economy.

But I haven't been idle.

I decide to work on and finish my book on my years in a band working for US forces in France more than 50 years ago! A way perhaps of not turning my back on Europe.

The book has now been completed and published. The image of the cover is below:

Clearly, I am in the business of seeking to get people to buy it and read it, so I hope you will forgive me if I tell you that it can be purchased directly from Waterstones here or from Amazon here.

Please read and tell your friends about the book.

Thank you.

Ps I hope to start writing some thoughts on economic and related matters quite soon.

28 June 2016

In this blog I shall set out some notes on the nature and direction of the impact of Brexit on the Scottish economy. The Fraser of Allander Institute will be revising its forecasts of Scottish GDP growth, job creation and unemployment in the coming weeks in the light of Brexit where specific numbers will be put on the forecast effects. This blog should in no way be seen as anticipating what the Fraser of Allander Institute will forecast or the nature and direction of anticipated effects identified by the Institute. What I write here is my personal view.

It is useful to use the analytical time frames of the short run and the long run in considering the economic effects of Brexit - see the excellent analysis by the National Institute for Economic and Social Research back in May.

By the short run, I mean a time horizon that stretches from now until roughly the end of 2017. By the end of 2017 the medium to long-term effects gradually start to kick in. But such effects only begin to make themselves felt after Britain has gone through the Article 50 process and finally leaves the EU with a new trading relationship between the EU and the UK agreed and that won't be until 2019 or even later.

Short-Term Effects

The short-run effects are largely what economists describe as macro stabilisation effects. We have seen over the last few days and are still seeing significant turbulence in the financial markets: a large fall in the exchange value of the pound sterling; falls in share prices across the major stock exchanges of the world. UK bank shares have particularly been hit, which, in part, reflects an expectation that UK banks will lose their regulatory protections to serve EU customers. However, as Simon Wren Lewis points out the media frenzy surrounding volatility in the financial markets may sound like a major financial crisis but "it is almost certainly not that."

Brexit has led to a significant rise in uncertainty about its impact on the real economy in the UK and elsewhere. Hence, the large flow of funds into long-term government bonds serving to depress yields. But note that confidence in the UK government has not evaporated because the yield on UK 10-year Gilts have fallen below 1 per cent for the first time. Moreover some of the financial market volatility is due to Brexit being unanticipated by the markets, which has led to more extreme movements in process than would otherwise have been the case. Volatility will diminish soon but it may take some time for sterling and share prices to find a new equilibrium because of the continuing uncertainty about the trading relations that will emerge once the Article 50 negotiations and bilateral trade arrangements with non-EU countries have been negotiated.

The significance of higher and continuing levels of uncertainty as a result of Brexit for the real economy is that risk premiums will rise. So, the exchange value of sterling will be lower in the long-run and the cost of borrowing to households, companies and government will be higher. Although, UK government debt may persist as a safe haven if political stability is restored within the UK and in view of the UK's ability to print its own money and borrow in its own currency there may be little rise in the cost of borrowing for the UK government.

The effect of increased risk premia, and increased cost of borrowing will, therefore, serve to lower household demand and fixed investment in Scotland and in the UK depressing aggregate demand. Demand will also fall because real wages and incomes are lower due to higher import prices following the large fall in the value of sterling. Uncertainty will also lead to planned investment projects being delayed, or even abandoned altogether. In addition, any slowing of economic activity will lower government tax revenues and push up government spending as the automatic stabiliser of increased social security payments, such as unemployment benefit, kicks in. Austerity could intensify if the UK government seeks to maintain its current fiscal targets. Moreover, a weakening of the housing market along with a possible lower levels of shares and other asset prices will depress household wealth holdings, which would serve to depress spending and output further.

For these reasons the short-term effect of Brexit should be to depress aggregate demand in Scotland and the UK. However, these effects will occur progressively while as we have seen the fall in sterling is immediate. The large fall in sterling will boost the competitiveness of Scottish exporters, although as costs rise this will disappear in the medium to long term. The rise in export competitiveness will boost the demand for exports and serve to some extent to counterbalance the short-term Brexit factors that depress aggregate demand. Moreover, there could be a further loosening of monetary policy if the Bank of England privileges demand and output maintenance above inflation - due to the effect of higher import prices - stabilisation.

The upshot of this is that the effect of Brexit on demand and GDP growth in 2016 is likely to be negative but small.

The short-term negative effects will strengthen in 2017 and possibly 2018, with the result that we should expect to see a sizeable slowing in growth compared with pre-Brexit forecasts over the next two years. A recession running for longer than two quarters is a distinct possibility.

Medium to Long-Term Effects

These effects are largely the consequence of the new trading relationship that will emerge after the formal Brexit progress is complete. There was a high probability that output and growth in the Scottish economy would be permanently damaged compared to the situation if Britain had remained in the EU.

First, the likelihood would be that the new trading relationship would be less favourable than in the EU. A key study by the Centre of Economic Policy (CEP) at the London School of Economics, estimated that even if a post-Brexit UK secured a free trade agreement with the EU, the effect on GDP through the loss of trade creation benefits is modeled to be around 2.2%. However, once the estimated dynamic losses of Brexit on productivity growth through reduced competition and reduced technological innovation linked to lower FDI inflows and reduced financial integration, CEP’s estimates of loss to GDP rises from 2.2% to 9.5%.

Secondly, this is an area where I fear that Scotland will suffer especially. Labour productivity is currently around 2.5% below the UK and academic estimates put overall productivity around 10% or more below the UK. Moreover, the weaker productivity position in Scotland is bolstered by success in attracting inward investment better than almost anywhere else in the UK. Not only would actual and potential Scottish exporters have to overcome their weaker competitive position due to lower productivity they would also have to face the additional hurdle of less favourable trading arrangements and the attendant loss of productivity enhancing inward investment, which has been key to the Scottish economy. The NIESR draw on the academic literature to estimate a decrease in foreign direct investment inflows to the UK of -24%. Given our past successes the loss to Scotland could be even greater.

So there is much to worry about concerning the future growth of the Scottish economy once Brexit is complete. It is quite understandable that these and other concerns have led to demands for a second referendum on Scottish independence from the UK. But as the data below suggest breaking the UK union might be more costly than leaving the EU Single Market.

Memorandum on trade and corporate links to EU and Rest of UK

On Scotland’s trade, the latest data is for 2014 published in Export Statistics Scotland 2014 (formerly the Global Connections Survey) in January of this year. This shows that the Single Market is much less important to Scotland than exports to Rest of UK. Exports to RUK are £48.5bn (64% of total) to the EU they are £11.6bn (15%) and to Rest of World £15.2bn (20%) and about 1% is unallocated.

I have no estimates of the total number of jobs linked to this trade but their share should be broadly pro-rata to the export sales shares. The Scottish Government's Boosting the Economy web page cites "Over 300,000 Scottish jobs were estimated by the Centre for Economic and Business Research to be directly and indirectly associated with exports to the EU in 2011” and this is similar to the 250,000 jobs cited by the pro- Europe campaign. But even if this figure is correct the jobs directly and indirectly associated with exports to rest of UK should be more than 4 times greater.

On jobs linked to ownership of companies based in Scotland, using Scottish Government data principally from Businesses in Scotland 2015 and from the Boosting our Economy page in the Benefits of EU membership section I roughly estimate the following job breakdowns:

When we examine the performance across different industries and sectors, we see that a continuation of the convergence in the pattern of growth between Scotland and the UK in the fourth quarter of last year.

Scotland is now relying solely on the service sector for growth as the contribution of Construction, driven by infrastructure spending, has now peaked, albeit at a high level of activity.

Slight negative growth in the production sector meant that the recession in the sector continued with negative growth having occurred in three successive quarters. Within production, manufacturing technically emerged from recession in the fourth quarter but manufacturing growth can only be described as weak.

Moreover, even though the service sector registered growth of 0.3% in the final quarter of last year, UK services grew three times faster and performance in all principal private subsectors in Scotland is appreciably weaker than their UK counterparts. Financial services are especially weak and the weakness of business services growth has been exacerbated by the effects of the fall in the price of oil.

These data continue to offer evidence of the continuing reliance of both the UK and Scottish economies on service sector growth and the failure to rebalance in favour of manufacturing which was the express desire of the UK Government.

III The labour market

The latest labour market data revealed a significant deterioration in performance as the job shedding associated with the consequences of the oil price fall and deteriorating export performance began to bite.

In the quarter to March 2016 the numbers in work fell by 53,000 (-2.0%) to 2,578,000. The last time there was a fall in jobs of this scale was back in early 2010.

Unemployment rose by 8,000 (+4.8%) to 169,000 with the rate rising to 6.2%, compared to 5.1% in the UK, a gap that is now the largest since mid-2004. Over the year, Scottish jobs fell by -45,000, a fall of -1.7%. Unemployment in Scotland rose by 2,000 over the year, or by 1%.

The numbers inactive rose in Scotland in the quarter by 49,000 or by 3.1%, while over the year, inactive numbers rose by 59,000 (3.7%) in Scotland.

As a result of this downturn in the labour market, by the end of the first three months of this year the gap between Scotland’s and the UK’s employment performance had widened considerably with Scottish jobs as reported in the LFS household surveys 0.9% above their pre-recession peak, compared to UK jobs which were 6.3% above peak.

IV Factors influencing future performance

Household demand and fixed investment will continue to drive growth in Scotland but with the stimulus from household spending and fixed investment weakening.

Household demand and fixed investment will continue to drive growth in Scotland but with the stimulus from household spending and fixed investment weakening.

Both investment and household spending will continue to be badly affected by the continuation of the low price of oil and associated job losses affecting household incomes and spending.

Household spending will be affected by the recent fall in the saving ratio ceasing as households possibly start to rein back their borrowing and spending. In addition, wage growth remains weak while the housing market seems to be weakening, which is also likely to have a detrimental effect on household spending.

Fixed investment will be affected by the decline in onshore investment in the oil service industry and related activities as well as the slowdown in infrastructure spending and construction activity.

It might also be the case that uncertainty about the outcome of the BREXIT referendum on 23rd June and its aftermath might encourage companies to postpone investment plans until the issue about Britain’s economic relationship with the EU is finally clarified.

Net trade will continue to have a negative effect on aggregate demand. Scottish exports (including trade with rest of UK) in current market prices have been falling since 2014 and Scottish manufacturing exports to the rest of the world fell in real terms in the second half of last year. The rate of growth in Scotland’s main export markets is predicted to fall.

Finally the continuation of the UK Government’s austerity programme means that there is little hope of a compensating boost to growth from this component of demand.

VI Forecasts

Output

On GDP, we have revised down our forecast for this year from 1.9% in March 2016 to 1.4%.

This downward revision is driven by slow investment growth, the continuing effects of the fall in the price of oil on household incomes and spending, a general slowing in household spending as the rate of household borrowing diminishes and a worsening demand for Scottish exports as global growth and growth in Scotland’s key export markets slows.

We are forecasting growth of 1.9% in 2017 a downward revision to our March forecast of 2.2%, due to an anticipated weakening of both domestic and export demand for goods and services produced in Scotland compared to our March forecast.

We are now forecasting 2018 and our prediction is that there will be growth of 2.0% as the economy returns to trend.

Jobs

We have revised down our forecasts for employee jobs because of the deteriorating conditions in the Scottish labour market.

The number of total employee jobs is still forecast to increase in each year with the number of jobs at the end of 2016 forecast to be 2,445,650, an increase of 1.2% during 2016.

Our new central forecast is that the Scottish economy will add 28,650 jobs in 2016, down by around 8,000 from our March forecast, with a net of 39,450 jobs added in 2017, down by more than 7,000 from our March forecast. Jobs growth in 2018 is forecast to be 47,379.

Unemployment

Our latest forecasts for the unemployment rate in Scotland for the end of 2016 is now 6.9%, with our forecast for this to fall to 6.7% and then 6.2% by the end of 2017 and 2018, respectively.

V Growth Policy

In this section of the Commentary we consider further the challenges facing the Scottish economy and turn to the question of policies to promote long-term growth.

We note that the Scotland’s Economic Strategy published by the Scottish Government in March of last year is the latest of many growth strategies produced by Scottish governments since devolution.

All of these strategies provide a strategic framework grounded in mainstream economic development theory, which essentially see economic growth as the consequence of productivity growth stimulated through the promotion of specific ‘supply-side’ change: improvements in innovation and R&D, enterprise, investment, competition, and skills.

But all of these strategies, including the current one, were stronger on the ‘what’ of growth promotion with much less emphasis on the ‘how’.

In other words, there needs to be more thought and debate on the operationalisation and implementation of the promotion of innovation, enterprise, investment and skills formation in Scotland. It is not new strategies the Scottish economy needs but clear insights and policy action on the implementation of Scotland’s Economic Strategy.

In view of this, we welcome the recent creation of the new Economy Secretary post in the Scottish Government and particularly welcome the new Minister Keith Brown’s early initiative in instituting a review of Scotland’s enterprise and skills agencies. If this review is undertaken in a positive way to help enhance the operational impact of the agencies, it could mark the beginning of a process where strategy implementation moves centre stage in economic policy in Scotland.

09 March 2016

Unfortunately, a bout of sickness has delayed me posting a summary of the latest FAI Economic Commentary. Here it is, and apologies for the delay:

I Overview

In our latest Economic Commentary we note that Growth in both the Scottish and UK economies is set to slow further with falling oil prices having a net negative impact on Scotland compared to the rest of the UK.

The chained volume measure of GDP rose by 0.1% in Scotland in the third quarter, 2015, (the latest data point) while UK GDP rose by 0.4%.

UK GDP (ex oil & gas) now stands 7.1% above the pre-recession peak compared to only 3.1% in Scotland. UK GDP - ex oil & gas - has had an even stronger recovery from recession than Scottish GDP and UK GDP as a whole.

Scottish GDP has recovered by 8.6% since the trough of recession while UK GDP - ex oil & gas – has recovered by 14.0% from its trough by 2015q3, compared to 13.0% when oil and gas output is included.

In the third quarter, UK GDP ex oil and gas rose by 0.5% - more than the 0.4% reported when oil & gas is included - and by 2.3% over the year, four quarters on four quarters.

II Industries and sectors

When we examine the performance across different industries and sectors, we see that the pattern of growth between Scotland and the UK again differed in the third quarter, but the divergence was probably less than in some earlier quarters.

In the UK, the service sector was again by far the main driver of the overall growth rate of 0.4% by contributing growth of +0.5% points. In Scotland the service sector was also the main driver of growth contributing +0.2% points.

The construction sector, which was the main driver of Scottish growth in the second quarter still continued to contribute positively but by only +0.1% in the third quarter, while the sector’s contribution to UK growth was again negative at -0.1% points.

The production sector continued the pattern begun in the second quarter of contributing negatively to growth in Scotland - by -0.2% in the third quarter - while making neither a positive or negative contribution to growth in the UK.

Within production, manufacturing in the UK made no contribution to growth, while making a negative contribution -0.1% points in Scotland, a continuation of the performance in the second quarter but a reversal of the earlier pattern. In Scotland electricity & gas also made a negative contribution to growth of -0.1% points, with the other production sub-sectors neither providing a positive or negative contribution to Scottish growth. The production sub-sectors in the UK all made a zero contribution to growth.

Despite the stronger performance of the service sector in Scotland, financial services activity continued to weaken with the prospect of recovery to pre-recession levels of activity now looking less and less likely.

The weakness of financial services and the negative impact of the low price of oil on business services were not, however, sufficient to halt the growth of business and financial services overall, which still grew by 0.3% in the 3rd quarter and by 1.4% over the year.

III The labour market

The weakness in Scotland’s GDP growth has not yet impacted overmuch on the labour market.

In the quarter to December 2015 employment rose by 22,000 (0.8%) to 2,636,000 while unemployment fell by 5,000 (-2.8%) to 162,000 with the rate falling to 5.8%.

Yet, the jobs recovery remains weaker than in the UK as a whole. By the end of the third quarter, Scottish jobs as reported in the LFS household surveys were 3.2% above the pre-recession peak, while UK jobs were 5.7% above peak.

IV Factors influencing the recovery and growth

Positive Influences

Domestic demand is still growing helped by the income effect of a low price of oil but may be beginning to slow as investment especially public infrastructure investment growth tails off.

Domestic inflation is close to zero, below nominal earnings/income growth, which is picking up slowly and so boosting real income;

Interest rates remain low and household demand boosted by some pick up in wages and earnings.

External demand for goods and services is being boosted by: the continued resilience of the US economy – despite the slowdown in US growth in the 4th quarter (and US growth was greater than UK growth in 2015 overall); and a gradual pick up in growth in the Eurozone as the risks of deflation appear to recede.

Threats

The low price of oil appears to be having a negative effect on Scottish growth, with negative supply effect outweighing positive demand effect. This negative effect is being sustained as the longer than expected delay in the recovery of oil prices is dampening overall investment expenditure.

Growth remains unbalanced with household spending the key driver fuelled largely by rising household debt. Household net assets are also high so there is a debate about the significance to demand of rising debt.

Net trade continues to be strongly negative with export demand threatened by the high level of sterling – although note the recent fall – slowdown in China and ‘policy normalisation’ in United States.

Fiscal austerity continues in the UK, although the tightness of fiscal policy was loosened after November’s Autumn Statement. The risk is that the Government fails to meet its fiscal targets as tax revenues fail to meet expectations and the government re-intensifies austerity in order to attain its targets. This appears to be about to happen in the forthcoming Budget as signalled by the Chancellor’s comments in China. If so, this would, in our view, be a major mistake. A fiscal tightening when growth is slowing is likely to slow growth further and reduce the tax revenues that the Chancellor desires to meet his fiscal targets.

The referendum on the UK’s membership of the EU announced for 23 June 2016 increases uncertainty significantly in the short term, which is likely to have a negative effect on investment as plans are postponed until the outcome is clear. Moreover, if UK voters do vote to leave the EU, this short-term negative impact on investment and growth is likely to carry over into the long term

Growth

Further analysis using new data on the long-term growth performance of the Scotland’s economy leads to the following conclusions:

On long-term growth performance, the main conclusions are:

Scottish ‘trend’ GDP growth of 2.1% p.a. over the last 50 years is lower than UK growth of 2.4% p.a. (under the former ESA 1995, Scotland’s ‘trend’ GDP growth rate over last 50 years was identical to UK growth at 2.3% p.a.)

Scottish ‘trend’ GDP per head growth over last 50 years is 2.0% p.a., the same as in the UK as a whole (under the former ESA 1995, Scotland’s ‘trend’ GDP per head growth rate was 2.2% p.a., faster than UK’s 2% p.a. – due to falling or slower population growth in Scotland).

Overall Scottish growth has been consistently weaker than UK growth since the 1970s, but up until the recent recovery the gap seems to have been narrowing.

After weakness in the 1970s and ’80s, GDP per head growth was stronger in Scotland relative to UK, until the recent recovery.

On productivity, the main conclusions are:

Labour productivity has risen absolutely in Scotland by 22% between 1998 and 2014

Despite this growth it fell behind the UK, which had faster growth to 2007, before the Great Recession.

Scotland’s relativity improved during and after the Great Recession, with the UK experiencing a greater deterioration in productivity - hence the post-recession ‘productivity puzzle’ is much more of a UK than Scottish phenomenon. However, by 2014 it was still about 2.4% below the UK.

However, academic research suggests that overall – i.e. ‘Total Factor’ – productivity in Scotland is much lower than rest of UK. In the absence of faster population growth, Scotland can only sustain an improved growth rate by raising its competitiveness through improved productivity.

V Brexit

The Institute’s analysis of the implications of Brexit for the Scottish economy leads to the conclusion that it is difficult to imagine that it would help improve Scotland’s competitive position with respect to our trade with the EU.

In recent years, the decline in electronics production and the erosion of Scotland’s manufacturing base has meant that Scotland has struggled to maintain its penetration of EU markets even on the favourable trading terms obtained through membership.

It is difficult to see how any post BREXIT trading relationship with the EU would be better than current arrangements.

So, not only would actual and potential Scottish exporters have to overcome their weaker competitive position due to lower labour and total factor productivity they would face the additional hurdle of less favourable trading arrangements.

There are several academic studies that seek to identify the impact of Brexit on the UK economy.

One key study in 2014, by the Centre of Economic Policy (CEP) at the London School of Economics, estimated that UK GDP would be reduced by up to 9.5% of GDP in a world where the UK cannot negotiate favourable trade terms with the EU. However, under a more optimistic scenario, in which the UK secures a free trade agreement with the EU, CEP estimates the losses to be around 2.2% of GDP. The static trade welfare effects of Brexit – i.e. the loss of trade creation benefits - are estimated by CEP to range from 1.1% to 3.1% of GDP. However, once the estimated dynamic losses of Brexit on productivity growth through reduced competition and reduced technological innovation linked to lower FDI inflows and reduced financial integration, CEP’s estimates of loss rise to 2.2% to 9.5%.

VI Forecasts

Output

On GDP, our forecast for 2015 – for which we do not have official 4th quarter data until April 2106 - is 1.9%, which is a slight revision down from our forecast of 2.0% in November 2015.

For 2016, we have also revised down our forecast from 2.2% in November to 1.9%. This is mainly driven by apparently slowing income growth, a weakening of previously strong domestic investment growth, and an extension of the expected period in which a low price of oil is likely to be sustained.

On our central forecast, we are forecasting a pick up in the rate of growth in 2017 as the economy rides out the challenges of 2016 and the price of oil in particular begins to rise to more favourable levels. But at 2.2% our forecast of 2017 remains below our November forecast of 2.5%.

Jobs

The number of employee jobs is forecast to increase in each year, and the number of jobs added in 2015, 2016 and 2017 has been revised down slightly since our November 2015 forecast.

The number of jobs at the end of 2015 is now forecast to be 2,415,200, an increase of 1.3% during 2015.

Our new central forecast is that the Scottish economy will add 36,800 jobs in 2016, down by around 9,000 from our November forecast, with a net of 46,850 jobs added in 2017, down by almost 8,000 from our November forecast.

Unemployment

On unemployment, our latest forecasts for the unemployment rate in Scotland for the end of 2016 and 2017 are 5.7% and 4.8% and for numbers 153,350 and 159,850, respectively.

11 December 2015

On Wednesday of this week - 9 December- the Office for National Statistics (ONS) published its annual update of Gross Value Added (GVA) and GVA per head for the Nomenclature of Units for Territorial Statistics (NUTS) 1, 2 and 3 regions and nations of the UK. This is a useful exercise although there are technical issues to be confronted in the construction of estimates of GVA across the UK regions and territories. The present data series is constructed using household income data, later this month - on 16 December to be precise - ONS will publish GVA estimates based on counting produced output: the two do not always produce the same result! A further point is that GVA is much the same as GDP. I won't go into the difference.

Anyway technical issues aside, I was interested to read In the Herald that Stewart Hosie, the SNP’s deputy leader and economic spokesman, in commenting on the publication had said

“Today’s ONS figures show, once again, that Scotland continues to punch above its weight in its contribution to the UK economy. The strong showing for Scotland is testament to the successful economic policies of the SNP Government from crucial infrastructure investment to vital support for small businesses.This has resulted in record numbers of registered businesses in Scotland, increased productivity, growing value of international exports, and record employment.”

I read these comments before I had chance to look at the ONS data. So, I thought: "That's interesting. If Scotland is 'punching above its weight it must mean that we are generating more income than our size (equals weight?) would warrant. The main indicator of a territories size is population, so according to Mr Hosie GVA per head in Scotland must now be higher than the UK. And, this might be due to SNP Government policy"

I rushed to look at the data and the chart below is what I found:

So, the chart reveals that on a reasonable definition of "punching above its weight" Scotland lags behind the UK as a whole. Indeed, the relative is lower than it was in 1997. It is lower than it was at the trough of the recession in 2009 but the high point of 97.2 was due principally to the recession being stronger in the UK than in Scotland. Between 2009 and 2012, the Scottish relative fell as the recovery from recession in UK GDP was faster than in Scotland. After 2012 the Scottish recovery picked up and so the relative rose a bit.

But there's little in these data to suggest that Scotland has exhibited a "strong showing" at all. It is true that Scotland moved into third position in the GVA per head rankings in 2013 just ahead of East England as the recovery in Scotland strengthened and this might have been influenced by SNP government policy in prioritising investment spending and the pick up in construction activity here. But as the chart below shows all regions and nations appear to have lost out to London during the recovery. If Scotland has managed to achieve "record numbers of registered businesses in Scotland, increased productivity, growing value of international exports, and record employment", which I think is not wholly supported by the data, it has not registered much, if at all, in the GVA relative and certainly could not lead one to conclude that Scotland is "punching above its weight."

26 November 2015

Several UK newspapers today trumpet the Chancellor's Autumn Statement yesterday as heralding the end of austerity. Nothing could be further from the truth.

Chart 4.10 in the Office for Budget Responsibility's (OBR) Economic and Fiscal Outlookshows the size of the state in Britain continuing to shrink dramatically.

From around 46% in 2010-11 total public spending as a percentage of GDP is projected to fall to 36.4% in 2020-21. This is as low as it was in 2000-01 after the long decline from around 48% after eighteen years of Conservative government - the 1997 Labour government initially adopted Conservative spending aggregate plans in an attempt to gain fiscal credibility. Prior to 200-01 the last time total public spending amounted to around 36% of GDP was in the mid 1950s.

The Chancellor may have done a U-turn on his plans to cut tax credits but he still hopes to cut the size of the British state by 20% in ten years, twice as fast as the paring back of the state under the Thatcher/Major governments.

13 November 2015

The latest labour market data show the situation up to end September. The data clearly show the slowdown that has recently occurred in the Scottish economy. Some comfort can be perhaps be obtained from the latest quarter's data, which could be interpreted as showing that the slowdown is coming to an end. I think, however, that would be a premature conclusion until we see more data.

Employment did rise by 3,000 in the latest quarter and by 9,000 over the year. But as the chart shows there is clear evidence that job creation has been slowing down in Scotland leading employment to fall further behind the UK. So, by Jul-Sep 2015 UK employment was 5% above its pre-recession peak whereas Scottish employment was only 2.1% above.

The same conclusion can be drawn by looking at the unemployment rate which has now risen to 6% in Scotland compared to 5,3% in the UK. The next chart shows the rate in the two jurisdictions.

What is revealing from the chart is that the unemployment rate in the UK has now moved below where it was just before the recession started whereas in Scotland it is more than 40% higher.

The next chart, which graphs the employment to working population ratio shows that there is still a lot of 'slack' in the Scottish labour market.

The ratio stand at nearly 3% below its pre-recession peak. On this basis we should not expect there to be much pressure on wages in the Scottish economy.

This downturn may be the effect of the sharp fall in the price of oil and if so we should expect this to begin to unwind soon with job creation picking up and unemployment moving on a downward path again. But if not, then we might be witnessing the end of the recovery.

12 November 2015

'Some of Britain's biggest retailers have warned stores could be forced to shed jobs in Scotland unless business rates are overhauled. Boots, Marks & Spencer and John Lewis are among 40 firms and business organisations that have called for a fundamental reform of non-domestic rates. They say business rates, which raise £2.8billion, place an "unsustainable burden" on them. In an open letter to The Herald, they describe rates as "a tax on jobs and growth" that "acts as a drag on the Scottish economy".

Gardham also reports that John Swinney, the Finance Secretary, defended Scotland's business tax regime as "already the most competitive in the UK".

My advice to John Swinney is that he should be a little skeptical of such special pleading by a business lobby.

The theory and evidence on business property taxation offers little support for the view that Scottish business rates are "a tax on jobs and growth” - see here and here.

John Swinney could have reasonably responded to this retail lobby that business rates:

Are only a small percentage of business costs usually ranging from 2% to 4%

Allow many companies to obtain tax reliefs and non-domestic rates can be set against Corporation Tax.

Allow local authority public service benefits to be received by firms; and

That the burden of non-domestic rates is in the long run unlikely to be borne by the users of the property such as the retailer: the incidence of the tax will differ from where the tax is levied.

A key question here is the tax incidence: Who bears the burden of a property tax?

In answering this question we need to distinguish between the short run and the longer run.

In the short run, theory and evidence suggests that the tax reduces profits, and in limited degree is shifted forward to consumers in the form of increased prices. The fact that profits of retailers and other payer of the tax may fall in the short run is likely to reduce investment and so those lobbying John Swinney do have a point. Moreover, the tax clearly introduces a distortion into the economy by disadvantaging property intensive economic activities and investments.

However, in the medium to long run the users of property will be able to negotiate a reduction in rents as a result of the tax. This is because the land and property is effectively fixed in supply, can’t be switched to other uses – especially the land = so there is little or no impact on economic behaviour. Its supply, to use an economic term, is zero elastic. Any reduction in rental value as a result of the property tax will generate a corresponding reduction in capital value. Hence this process is known as ‘tax capitalisation’. Evidence is typified by this study, which found that:

“The average capitalisation effect obtained was not significantly different from 100% implying that all of the local tax exemption benefits accrue to the owners of the property."

And this is why studies tend to find little or no effects of business rates on jobs and output in rated activities and hence why we should be skeptical of the current business lobby against the current levels of business rates in Scotland.

This does not of course mean that business rates are a ‘good tax’ and should not be abolished.

Business rates tax both land and property. As we noted above, because the supply of land is effectively zero elastic a tax on land simply takes away economic rents and does not distort behavior. However, taxes on investments in, and improvements to, property per se are a tax on business activity and so will distort behavior. The former land element of the tax is ‘good’ the latter property alone element is ‘bad’.

The logic of this argument is that John Swinney should respond to the current lobby against business rates by accepting the distorting effects of the property element and that he will seek to abolish the property element by moving towards a land value tax (LVT).

The case for replacing business rates with a LVT and the associated costs and benefits is well set out by Nobel prize winner Professor Jim Mirrlees in chapter 16 of his review of taxation in the UK for the Institute of Fiscal Studies, which can be accessed here.

It is on such rigorous theory and evidence based reviews that policy should be based and not the lobbying of self-interested groups

09 November 2015

I see the well-known economist and FT columnist John Kay has suggested that the financial services sector in Scotland will never recover from the failure of its two largest banks at the height of the banking crisis in 2008. Specifically, John Kay is reported as saying that

“We’re never going to recover the position that we had for centuries in banking – and that’s a tragedy.”

“Scotland’s diversity as a financial centre – we’re not just providing banking but also asset management, pensions, insurance, asset servicing all kinds of other services – has given us resilience. In terms of job numbers, we are roughly where we were in 2008 – a much better outcome that some were expecting."

So, what is the evidence?

On the real value of output, the evidence to date favours Professor Kay as the chart below shows

The real value of output in financial services in Scotland is currently -13.4% below the sector's pre-recession peak. This is little different from the -15.5% that was lost to financial services in Scotland as a result of the recession.